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May 9, 2016

In some good news for commercial vendors, the Supreme Court of Texas recently ruled that payments for ordinary services provided to an insolvent customer are not recoverable as fraudulent transfers, even if the customer turns out to be a “Ponzi scheme” instead of a legitimate business.

In Janvey v. Golf Channel, Inc.,[1] the Court considered whether, under the Texas Uniform Fraudulent Transfer Act (“TUFTA”), a vendor should be required to return payments it received in good faith for services rendered simply because its customer turned out to be a Ponzi scheme and not a lawful business.[2] Ultimately, the Court determined that the objective market value of services provided in the ordinary course of business serves as a defense to a fraudulent transfer claim, despite the illegitimate nature of the Ponzi scheme. In reaching that conclusion, the Court rejected the contention that the

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In some good news for commercial vendors, the Supreme Court of Texas recently ruled that payments for ordinary services provided to an insolvent customer are not recoverable as fraudulent transfers, even if the customer turns out to be a “Ponzi scheme” instead of a legitimate business.

In Janvey v. Golf Channel, Inc.,[1] the Court considered whether, under the Texas Uniform Fraudulent Transfer Act (“TUFTA”), a vendor should be required to return payments it received in good faith for services rendered simply because its customer turned out to be a Ponzi scheme and not a lawful business.[2] Ultimately, the Court determined that the objective market value of services provided in the ordinary course of business serves as a defense to a fraudulent transfer claim, despite the illegitimate nature of the Ponzi scheme. In reaching that conclusion, the Court rejected the contention that the value provided must flow directly to the Ponzi scheme’s creditors.

A quick refresher on fraudulent transfers: The Uniform Fraudulent Transfer Act (and its bankruptcy counterpart, Section 548 of the Bankruptcy Code) prevents a debtor from improperly moving assets beyond the reach of creditors. As one example relevant to the Janvey case, an asset may be recovered for the benefit of creditors if the debtor transferred it “with actual intent to hinder, delay, or defraud” creditors, unless the transferee took the asset in good faith and for reasonably equivalent value. Factors indicating fraudulent intent include transfers to insiders, concealment of the transfer, or debtor-retained control of an asset after the transfer, all of which are questions of fact.

When a Ponzi scheme is involved, courts generally bypass analyzing such “badges of fraud” and conclusively presume that all transfers in furtherance of the scheme—even to legitimate creditors with no role in the fraud—are made with actual intent to defraud because the underlying business is inherently illegal and insolvent. In addition, the nature of the Ponzi scheme raises doubts about a vendor’s normal defense that it provided value, because the “value” the vendor provided does not necessarily improve the position of the scheme’s creditors – it actually unwittingly allows the illusion of the Ponzi scheme continue, keeping the scheme afloat to defraud other investors. Indeed, this was the position the United States Court of Appeals for the Fifth Circuit took in Janvey before vacating its initial opinion and certifying this state law question to the Supreme Court of Texas. 780 F.3d at 647.

In Janvey, The Golf Channel (“TGC”) had a media-advertising services contract with Stanford International Bank Limited (“Stanford”), receiving $5.9 million for its advertising services. When Stanford became exposed as running a Ponzi scheme, a court-appointed receiver sued TGC to recover the transfers as fraudulent, asserting that the $5.9 million TGC had received did nothing to benefit Stanford’s defrauded investors or creditors, even though the same services would be valuable to a legitimate business. The receiver contended that, under the statute, the meaning of “value” should be measured only by the actual utility of the services to the creditors, categorically rejecting the market value of the services as a relevant consideration. The Fifth Circuit initially agreed with the receiver (in a decision that shocked many), then vacated its opinion and asked the Supreme Court of Texas to interpret applicable Texas law under TUFTA.

Luckily for TGC and all other good-faith commercial vendors, the Supreme Court of Texas did not adopt the receiver’s position. Instead, the Court determined that incidental involvement in a Ponzi scheme is insufficient to negate the objective value of services provided, holding that a showing of “reasonably equivalent value” sufficient to defend the fraudulent transfer claim can be satisfied with evidence that the transferee (i) fully performed under a lawful, arm’s-length contract for fair market value, (ii) provided consideration that had objective value at the time of the transaction, and (iii) made the exchange in the ordinary course of the transferee’s business. The Court opined that an objective inquiry that considers the existence of “value” from a reasonable creditor’s perspective at the time of the transaction is consistent with the statutory language and strikes an appropriate balance between protecting creditors and protecting vendors who have given reasonably equivalent value in good faith. (BTW, for another post on protecting vendors from avoidance actions where the vendor is not the least bit at fault, read this post from our fellow Bankruptcy Cave bloggers, here.)

A contrary holding would have required vendors to determine not only each customer’s creditworthiness at the outset of a relationship, but to monitor the legitimacy of the customer’s business at all times – impossible for any vendor to do, especially with investment schemes that appear for years to be legitimate businesses. For now, as long as vendors meet the standards outlined about regarding the objective value they provide, they should be safe from fraudulent transfer claims – at least in Texas.

[2] The Supreme Court of Texas undertook this analysis on a certified question from the United States Court of Appeals for the Fifth Circuit. SeeJanvey v. Golf Channel, Inc., 792 F.3d 539 (5th Cir. 2015). In certifying the question to the Supreme Court of Texas, the Fifth Circuit, enbanc, vacated its earlier panel decision that would have required The Golf Channel to return the payments at issue. SeeJanvey v. Golf Channel, Inc., 780 F.3d 641 (5th Cir. 2015).

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